Investors don’t usually have to think much about clearing houses – if they do, that’s usually a bad sign.
That crucial piece of plumbing in the financial marketplace was in focus after Robinhood and a number of other brokers outraged individual investors – and a few lawmakers – on Thursday over the high-flying GameStop Corp. trade. GME limit,
and shares of other companies with a high short position.
While the action sparked some conspiracy theories about alleged collusion between hedge fund managers and brokers, the brokers seemed to have little choice as the clearing house, shocked by the volatility in GameStop and other stocks, increased the amount of collateral the brokers had to purchase. posts to ensure that the transactions are settled.
While it may seem to an investor that a trade looks like an instant trade, there’s more to it. In fact, it usually takes two days for the transaction to complete and the money and securities to actually change hands.
Clearinghouses stand between buyers and sellers and ensure that the transaction is completed if either party defaults. Clearing houses require their members – banks and brokers – to be well capitalized, to deposit collateral and to deposit in a default fund.
When trading becomes volatile, the risk of default increases, especially when investors buy shares at margin or with money borrowed from their broker. Clearing firms understandably get nervous and may require brokers to increase the amount of collateral they have to pay to clear their trades.
That was in play on Thursday. WeBull Financial LLC Chief Executive Anthony Denier told The Wall Street Journal that the broker’s clearing firm was told by the Depository Trust & Clearing Corp., which serves as the central hub for clearing operations, that it should deposit more collateral.
As a result, WeBull, like Robinhood and other online brokers, moved on Thursday to limit trading on GameStop and other volatile stocks. The New York Times reported that Robinhood used lines of credit to meet its collateral obligations, while raising about $ 1 billion from investors to facilitate transactions in GameStop and other popular stocks.
For a detailed look at what was going on – and how the Dodd-Frank legislation that came into effect after the 2008 financial crisis to mitigate the danger of a system failure – dive into the following Twitter thread:
Brokers eased restrictions on purchases of GameStop and other stocks on Friday. GameStop was up 32% in the Friday afternoon action, putting it on track for a weekly rise of nearly 300% as it changes hands near $ 260 a share. It ended 2020 below $ 19 per share.
However, the broader US stock market was stumbling, with significant benchmarks for large weekly losses. The Dow Jones Industrial Average DJIA,
was low outside of his session but remained 540 points or 1.7% lower, while the S&P 500 SPX,
lost 1.7%. Both the Dow and S&P 500 were on track for weekly declines of about 3%.
The rally in heavily shorted stocks targeted by an army of individuals through Reddit’s WallStreetBets forum and other online platforms seemed to be hurting hedge funds. Analysts blamed the broader sell-off in part on the forced liquidation of profitable long positions by hedge funds and other investors who needed cash to cover losses on losses from short positions.
But a more crucial concern for investors is whether the speculative frenzy surrounding GameStop could trigger a wave of cascading losses that could threaten the financial system.
Chester Spatt, a professor of finance at Carnegie Mellon University’s Tepper School of Business and a former chief economist with the Securities and Exchange Commission, said he was optimistic that the problems surrounding the short squeeze were limited to a relatively small portion of the market.
“But it is important that intermediaries take steps to prevent private investor losses from penetrating the system, so I think steps like yesterday’s were important,” he said.
Meanwhile, Deutsche Bank macro strategist Jim Reid noted the results of a flash poll of the bank’s customers, which he said generated 700 responses but showed little consensus about the major threat to financial stability the situation (see chart below).
German Bank
“The high number of responses to this poll in a short period of time indicates that the topic is gripping financial markets, and the widespread dissemination of opinion suggests that markets have still not come to terms with the consequences (if any) of an epic week. , ‘he said.